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Industrial Development. An option for diversifying Cambodian economy. Supreme National Economic Council Cambodia Economic Forum 4 Peace Building, 16 February 2011. Objectives. The exercise aims to study direction and framework for formulation of industrial policies
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Industrial Development An option for diversifying Cambodian economy Supreme National Economic Council Cambodia Economic Forum 4 Peace Building, 16 February 2011
Objectives The exercise aims to study direction and framework for formulation of industrial policies Strategic thrust of the report includes: to discuss approach for reoriented industrial development policy to identify potential sector for industrial development to identify key macro and sectoral issues that constraint industrial growth to draw policy Implications Inputs received in the Forum will be in depth consideration for further refining the report
Content Rationale and potential for industrial development. Identification of sectors with growth potential Issues in industrial development Policy implications and preliminary recommendations
1. Why industrial development? Where Cambodia is today. During 1994-2009, GDP growth averaged 7.9 percent, poverty incidence declined to less than a third with notable progress on key social development indicators Three key sources of growth emerged viz. agriculture, garment manufacture and tourism. Recently, construction has also been a significant contributor to growth performance. However, the Global Economic Crisis of 2008-2009 halted the smooth economic progress of Cambodia requiring a review of its current economic development strategy. Cambodia has to contend with a vastly changed external economic environment. The changes include: Slow down in external demand in the traditional markets of developed countries Increasing competition in international markets Emergence of China as a driver of global economic growth and its shifting comparative advantage to new areas Increasing food and energy prices As a result, sustaining future growth is going to be challenging and social development might come under threat. Cambodia will have to rethink and reconfigure its development strategy.
1. Why industrial development for Economic Diversification? Recent growth resulted from the expansion of industrial base, though the base is still quite small: During 1995-2010 the share of Agriculture to GDP declined from 45% to 30%, Industry increased from 15% to 30% and Services contributed around 40% of GDP. Urbanization has increased (78.4% in 1993, 83.4% in 2008) Agriculture employs 70% of labor force vs. 10% by industry). Labor productivity of Agriculture has stagnated, but increasing in industry Industry did not significantly absorb new entrants to labor force and there is steady migration out of the country
1. Why industrial development? Future Growth Prospects Based on an analysis of decomposition of growth Cambodia’s total factor productivity (TFP) growth was only 1.0% during 2001-2008. If TFP growth could be maintained at this level, GDP growth is projected at 6.2% per annum At this growth rate Cambodia will reach lower middle income status in the next 5-10 years and upper middle income status in the next 35-40 years Accelerating TFP by reconfiguring industrial development could shorten the development trajectory It is not easy, but possible.
1. Do opportunities Exist? Availability of Capital: Cambodia relies on ODA and FDI for investment. Due to the current low interest rate policy of US and other developed countries, international capital may flow to the region including Cambodia if a favorable political and economic environment prevails. Structural change of global market: Asia could become a source of expanding demand that Cambodia can supply, especially agricultural goods. Moreover, rising labor costs in China could provide opportunities for relocating industrial facilities in Cambodia. Connectivity and market access: Cambodia is strategically located in the region and the globe and presents excellent location advantages for industry. It has reasonably well developed internal connectivity which is being continuously strengthened. Membership of Cambodia in ASEAN and WTO is already established. Advantages of starting late: Cambodia could skip some of the hardships and costs of moving on the learning curve in acquiring knowledge.
1. Seizing Opportunities: Is it Feasible? Strong Foundations Stability and peace Good connectivity within the country Open to regional and global economy High return on capital Young and dynamic labor force Abundant natural resources Reform oriented and strong government Required actions Clear policy direction and adjustment A proactive industrial development policy Strong policy implementation
2. Identification of sectors with good growth potential Market is the best mechanism for achieving sector diversification, however using the several successful models in the region government could play a mentoring and facilitating role in industrial development. Basis of sector identification Factor endowment: labor, land, minerals Stage of development of industry Investment and trade data Trade opportunities Revealed Comparative advantage Export of raw forms of agricultural and labor-intensive products; import of processed goods, machinery and many other manufactured products Investment is focused in Agriculture, construction, labor-intensive manufacturing and mineral resources Comparative advantage of Cambodia seems to lie in resource based and labor-intensive activities.
2.Sectors with growth potential Cambodia's key challenges in industrial development Continue "Take off" stage, avoiding the risk of reversal of structural change (decline in share of industry in GDP from 2004) Low food price is necessary to keep wages low to maintain competitiveness High investment to drive growth Strengthen existing industrial growth pillars and search for new sources of growth Three-main approaches emerge Capture more value-added in the existing industries with revealed comparative advantage Upgrade potential/emerging industries both for import substitution and export Discover latent comparative advantage
2. Sectors with growth potential Capturing more value-added Agriculture: develop forward linkages Garment, footwear and accessories: develop backward linkages/clusters Tourism: diversify into activities with high revenue earning potential Upgrade potential/emerging industries Furniture/handicrafts Regional and global production chains Revival of old industries (Sugar, paper, tire manufacture, import substitution) Construction materials Household appliances Oil, gas and mining Discover latent comparative advantage ITC (Software), chemical industry, renewable energy Supply line of regional and global heavy industry Creative industry (Electronic Arts, Animation, cultural hub of the ASEAN)
3. Government’s role in industrial development A supporting institution (a public good) is needed to facilitate (coordinate) the interaction of capital and knowledge.
3. Issues in capital accumulation Current status Gross saving ratio is around 20% of GDP, gross investment ratio around 25% of GDP; the I-S gap is met by ODA and FDI High intermediation costs: Low interest rate for saving, high rate for investment Absence of capital market as a resource to fund long term capital Issues/diagnosis strengthen mechanisms for mobilizing savings: tax collection, fully funded pension schemes, capital market development Improve the intermediation performance of the banking system Address asymmetric information issues: accounting practices, transparency, credit information, risk assessment Attract more FDI and maintain ODA inflows
3. Issues in knowledge accumulation Current Status Provision of skilled labor and management is dominated by foreigners (95% of garment industry is owned by foreigners) Economy could not exploit unskilled labor/resources resulting in underemployment/migration Cambodia exports unprocessed goods and services Issues/diagnosis Missing-middle in the education system (to provide basic interpersonal human skills to potential unskilled labor) Supply-demand mismatch in higher education –very few engineers and management graduates and too many graduates in humanities. Lack of investment in quality education (Low standards and focused on short term employability) Lack of investment in research and development Little technology and skills transfer from foreign investment.
3. Issues in institutional framework Current status Domination of informal and poorly managed micro businesses High transaction costs (utility charges, informal fees) Unfriendly business environment (unfair competition, smuggling, unpredictability of administrative and judicial decisions, uncertainty, poor access to information ) Issues/diagnosis Weak government institutions (capacity, incentives, public-private interface, predictability) Low investment in public goods (infrastructures, facilities, information, knowledge accumulation) Coordination failure among market players in industry Lack of competitive environment for growth
4. Policy implications: Macro Capital Accumulation Promote capital market development Enhance custom/tax collection administration Modernize pension system and establish other forms of saving mobilization Further strengthen banking system (encourage financial deepening) Encourage fair competition and expansion of MFIs Promote accounting practices among SMEs through grant, special training, and credit schemes Develop credit information system Improve risk assessment capability of FIs Provide government-led guarantee mechanism and financial leasing (facilities, machinery),
4. Policy implication: Macro Knowledge Further reform education system by providing emphasis on technical training, sciences and human skills Create conditions for for-profit universities to investment in quality education, knowledge and development of managerial skills Provide incentive to vocational training institutions that have linkages with SMEs (location, coordination, information sharing) Provide scholarships for engineering study (not only training to be teachers) Promote training in more skill sets (basic human skills, core and soft) Provide grants to industry for technology assimilation, adaptation and development Provide tax and other forms of incentives to firms that build and maintain strong linkages with educational institutions
4. Policy implications: Macro Improving institutional framework Incentivize/compel public institutions to provide business friendly services (application processing, registration, licensing, information) Concentrate public investment on infrastructure, facilities, information collection, logistics, ports and railways Continue investment in energy in order to reduce operation costs, especially early completion of the national grid Enhance rule of law to ensure favorable business climate Encourage public-private partnerships Reward successful businesses (large, medium and small) for good practices in export performance Establish professional and comprehensive FDI supporting services
4. Policy instruments and incentives Procurement policy can be used to create demand and favorable conditions for industrial development while ensuring domestic competition. Taxation policy should be restructured to provide incentives for sunrise and disincentives for sunset economic activities. Cambodia standards and SPS measures should be used for technology upgrading and expansion, trade regulation and moving up the quality ladder. A liberal trade regime is necessary for reciprocal market access. Special Economic zone is a tool for experimenting with some measures on a limited scale when their cost is too high if applied to the entire economy and where the results are uncertain. Industrial parks/cluster is a tool for increasing productivity, reducing costs and accumulating knowledge in a certain sector. Strict enforcement of the law is needed to ensure fair competition Monitoring instrument: export performance is a good indicator for measuring the international competitiveness of industry.
Conclusion and Priorities Past achievements were significant and have laid a strong foundation for further and sustained industrial development. The current policy of the Royal Government is well aligned with the principles of market oriented industrial development. However, the government could engage in a more nuanced industrial development strategy to address the challenges faced by Cambodian industry today. In the medium term, agribusiness is key sector to focus on since it could generate considerable externalities (involving many stakeholders, more efficient financial intermediation, infrastructure and entrepreneurship development) and impacts (income distribution, and slowing down urban migration, and emigration).
Conclusions and Priorities In the medium to longer term, the garment sector could evolve further as Cambodia has already established a firm foothold in the global market and network. In any sector, capital, knowledge and supporting institutions are needed to propel the development of the sector. However, the needed interactions between the three elements can differ from industry to industry. RCI in the region has been mostly public sector driven. Private sector must take more initiative to integrate Cambodia into the regional and global production networks using a win-win approach. Industrial development must be accomplished under the leadership of the private sector. Government role in industrial development is more direct in creating favorable supporting institutions and infrastructure development. However it should also play a key role in addressing issues in capital accumulation and knowledge generation. Government should intervene to correct market failures resulting from high transaction costs, inefficient resource allocation, asymmetric information, lack of investment and organizational weaknesses.
